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The European Commission today published its long-awaited report aimed at shaking up the over-the-counter derivatives market. The report advocates that clearing "grow substantially to cover large parts of OTC derivatives”, but stopped short of calling for trades to be forced onto exchanges. Financial News summarises the main points.

• Central clearing is the most effective way of reducing credit risk and is broadly feasible in all market segments. Clearing can grow substantially to cover large parts of OTC derivatives, although it cannot apply to all contracts.

• Where clearing is not “easily applicable”, common European rules are necessary to broaden its use. OTC products and markets should be standardised as a means of improving operational efficiency and cutting risks, bilateral collateral management should be strengthened and a central storage centre should be created to house all contract details.

• A data repository exists for credit default swaps and could potentially be used for other derivatives as well. European regulators are currently carrying a feasibility study for data repository based in the European Union.

• There are benefits to moving standardised OTC derivatives contracts onto trading platforms, as this would improve price transparency and reduce risk. However, such a move could limit the ability of companies to manage all of their risks. The Commission said it will examine this matter further.

• OTC derivatives vary substantially. Some market segments – such as interest rate derivatives and foreign exchange derivatives – already have strong risk management systems in place, while other segments – such as equity derivatives – have less developed infrastructures.

The recommendations are a response to fears that the OTC derivatives industry poses a systemic risk to the financial markets.

The report said: “The near-collapse of Bear Stearns in March 2008, the default of Lehman Brothers on 15 September 2008 and the bail-out of AIG on 16 September highlighted the fact that OTC derivatives in general and credit derivatives in particular carry systemic implications for the financial market."

The report calls for a “deeper discussion on how to reconcile the clear value played by OTC derivative markets [in managing] specific, non-standard risks with an a priori societal preference for transparent trading venues…for the purpose of risk assessment and price determination.”

It was originally expected that the report would be published last month to coincide with similar plans published by US regulators, but the announcement was twice delayed.